Stylish Renovations. Smart Investments.

Funding Your First Real Estate Deal

In last week’s blog post, Real Estate v. Stocks, I showed how real estate is one of the best investments for growing wealth quickly. But, how can you obtain the funding to even get started buying your first rental or flip? This is not a problem for folks who are flush with cash, but for the overwhelming majority of us, funding our first deal can be a challenge. So, this post is all about funding to get started acquiring rentals or flipping properties.

Self-funding may be out of reach for some. But it is not impossible. The downturn in the real estate market during the recession meant that real estate prices dropped significantly. Of course, the market is now recovering gangbusters, but there are still low-priced properties to be found, depending on your specific city and neighborhood. If you can find an inexpensive property with little renovation work to do or you can do the work yourself, your chances of being able to self-fund increases significantly. Taking a loan from your 401K (max allowed is $50,000 or 50% of the amount in your 401k, whichever is less) or using the equity in your personal home can be a way to self-fund, or at least obtain the down payment needed for other funding methods below. I mean, why not be your own bank? That’s how I got started. I used a 401k loan to purchase a really cheap condo in decent condition at auction that my Dad and I fixed up ourselves!

Seller-financing is a great way to fund your first acquisition if you don’t have any or very little funds at all to get started. Essentially, this means the seller is willing to transfer the property to you, then take a mortgage on the property in the amount of the sale price and have you make payments to him or her over an agreed-upon time-period until the mortgage is paid off. Essentially, the seller is the bank. It’s not easy to find these types of deals—it usually takes a great deal of diligence to find a property owner willing to sell at below market value (making it a good investment) AND willing to do seller financing. But if you can, it’s a great way to get started with very little to no money.

Traditional bank financing is great if you can get it, but it is oftentimes not available or practical when purchasing investment properties. For one, many investment properties are in such a condition that the banks will not lend, such as missing appliances or flooring, damaged roofing, or structural issues. Second, properties bought through an auction– where many of the best deals are—are often cash-only. Third, qualifying can be difficult, because banks will require that you meet certain credit requirements as well as their debt-to-income ratios and will not count anticipated rents as income. That means, you must be able to show you can pay the mortgage or rent on your personal property and other debt AND the additional investment property mortgage, which can be difficult. Finally, banks often take longer to close than sellers of distressed properties like, therefore disadvantaging you as compared to your competition who is not using bank financing.

Hard money lenders are institutions that will lend money to investors and often do not have the same restrictions of traditional banks. One such example is LendingHome, the hard money lender I sometimes use. The advantage of hard money lenders is that they often lend with priority for approval placed more on the property value as opposed to your credit score. Additionally, their approval process is often much quicker than traditional banks—7-20 days—and this allows you to write more competitive offers on homes. Also, many distressed properties sold through online auction houses require “cash only.” Yet, hard money generally is still considered acceptable in those transactions.

The disadvantage of using hard money lenders is that their fees and interest rates tend to be higher than traditional banks. And they still require you to put down 10-20% as well as have proof of funds to cover at least 6 months’ worth of mortgage payments to them.

Private money lenders provide the most flexibility. Who is a private money lender? It can be a friend, relative, colleague, angel investor, anyone who agrees to lend you the money for your property acquisition. The clear advantage to private money lending is that the parties are free to structure the transaction and terms however they want (within the law, of course). So, if Uncle Investor agrees to lend $100,000 for you to buy a rental property and allows you to pay it back over 80 years at 4% interest with the option to suspend payment during property vacancies—well, have at it!

The downside to using private money lenders is that not many of us know of rich relatives or friends willing to lend large sums of money. Or at least we think we don’t know any, because money discussions are often taboo. Keep in mind this phrase, you don’t know if you don’t ask. I’m not saying to indiscriminately hit up everyone in your circle, but a big part of venturing into real estate investing is being courageous. Even if they aren’t willing or able to lend the total purchase price, they may be able to fund the down payment you need for traditional or hard money financing. So, broach the subject, offer a good interest rate, show him/her the ROI numbers, and demonstrate your trustworthiness. You’d be surprised at the number of people looking to diversify their investments or to make returns that beat traditional investments like the stock market.

Personal loans and credit card advances may also be a way to obtain financing, particularly for a down payment; however, these loans can be very exorbitant, even upwards of 30% APR. So, you want to be sure that the deal numbers warrant the high interest rates, and that you have a clear, sure way to pay the money back!

Hopefully, you found this information useful. If so, like, share, and subscribe to our website to “share the wealth” (pun intended) and stay abreast of future info goodies. Also, check out prior posts by visiting our blog page HERE.